Diversify in private equity to avoid vintage risk

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When it comes to diversifying within private equity funds, it is important to consider vintage risk, caution those advising investors who are entering the private-equity space.

Private equity funds typically have a lifespan of about 10 years, so the ‘vintage year’ of the fund refers to the starting point of that fund, or the year it starts allocating capital.

If you’re thinking the references to vintage sound like an homage to wine, you’re partially right. Just like wine, funds have good years and bad years, and the vintage year can have a significant impact on its returns.

And, while private markets are not as susceptible to fluctuation as public markets, there are still financial cycles within those markets. So, just like buying wines from the same year would be considered risky, even if they’re from different vineyards and regions, the same applies to funds.

Investors might be well-versed in diversifying their portfolio with a variety of investments from different sectors, asset classes and risk levels. But the year of investment in an equity fund can be just as important in order to avoid being exposed to the same ups and downs (such as inflation or recession) experienced within that calendar year, explains Steve Balaban, chief investment officer for Mink Capital.

Families can make this mistake when moving money to private equity

“The challenge sometimes that families do and it’s horrible to see this is: A family hears about private equity, they didn’t know much about it, they get really excited. Then they take all the money that they want to put in private equity and they invest it in different funds in the same year because they just found out about it,” says Balaban.

“Now they’ve diversified their portfolio away from the public markets but their private equity is overly concentrated in one year. Then that’s a big challenge because it’s hard to predict what’s going to happen [in the economy] that year.”

Vintage risk also applies for those wanting to invest in venture capital (VC) and, with family offices becoming more active in the VC space, it is a factor to consider.

According to a January report by SVB Capital and Campden Wealth, Family Offices Investing in Venture Capital, family offices around the world mitigate vintage risk by investing across an average of eight years. Indeed, 17 per cent of the survey’s respondents reported having investments in as many as 16 different years.

For high-net-worth investors embarking on a private equity strategy, it is also important to find experienced private equity managers who have the networks, discipline and knowledge to avoid overpaying in frothy markets and who can identify the most beneficial selling conditions, maximizing value in any market.

So when it comes to diversifying investments in private equity funds or venture capital, the year should be a consideration.